Anatomy of a pension scheme’s carbon reduction

In its first Task Force on Climate-Related Financial Disclosures (TCFD) report, one of the UK’s largest occupational pension schemes, the £18.2bn Legal & General WorkSave Mastertrust, with 1.64 million members, announced it had considerably reduced its carbon footprint across default funds.

Between the end of 2019 and the end of 2021, the Target Date Fund (TDF) “growth phase” reduced its carbon footprint by more than 50%. And in the “approaching retirement” and “retirement” phases, it achieved reductions of 46% and 39%, respectively.

Scenario analysis played a crucial role in achieving these reductions.

The Mastertrust team assessed the potential impact of global temperature increases and government actions on its assets, liabilities and investment strategy under three scenarios: 1.5°C Net Zero, Well-Below 2°C, and Well-Below 2°C Disorderly.

This analysis found that equities were more sensitive to changes in companies’ net earnings, and higher-carbon sectors were more at risk of a high-carbon price but may have more opportunities to benefit from transition through competitive advantage.

Moreover, companies operating in countries with a higher-emissions intensity – such as commodity producers – may be at higher risk of the macroeconomic impacts of a carbon price.

Targeted changes and reallocations

Using this data, a reallocation of the scheme’s underlying funds played a significant role in the reductions.

Nicola Lonergan, head of the mastertrust and independent governance committee at Legal & General Investment Management (LGIM), says the TDF switched to LGIM’s Future World Multi-Asset fund as the main diversified growth fund component from Legal & General’s PMC Multi-Asset Fund 3.

This change considerably reduced the TDF’s carbon footprint, as the Future World Multi-Asset fund saw a 25% reduction in its carbon footprint over two years.

The Legal & General PMC Multi-Asset Fund 3, a default fund for the WorkSave Mastertrust, also significantly reduced its carbon footprint, which shrunk by 23%.

Lonergan attributed the reduction in the Multi-Asset Fund’s carbon footprint to a change in its listed infrastructure exposure, “a key front line in the decarbonisation of the economy”.

She says: “This reduction arose from a combination of overall allocation change, reallocation within the asset class, as well as company-level decarbonisation of the sector itself.”

One way the asset manager achieved this was by allocating more to renewable energy generators and cleaner sectors within its infrastructure portfolio.

Targeted changes in exposure had a significant impact on the carbon footprints of the mastertrust funds, too, says Lonergan.

“For example, the exposure to coal companies, defined as having 20% of revenue from coal, has fallen by 63% in the Future World Multi-Asset fund and 30% in the Multi-Asset fund from 2019 to the end of 2021,” she explains.

Emerging ESG reporting standards

With TCFD now a fundamental industry framework – and enshrined within UK law - there is a greater demand for accurate, climate-related information along the investment chain, says Lonergan.

“As the regulatory backdrop for ESG reporting has evolved, we have seen various standards for ESG reporting emerge,” she says. “It is vital for industry standard frameworks to ensure consistency and the quality of ESG data and metrics in reporting disclosure.

“To date, these reporting standards have been predominately linked to climate metrics, while other key themes such as biodiversity and deforestation continue to have less stringent reporting frameworks associated with them.”

To help investors understand how funds are impacting the climate, Lonergan says LGIM is providing ‘Implied Temperature Alignment’, a forward-looking measure that indicates how corporate and sovereign issuers are aligned with the Paris Agreement or net-zero targets.

She says: “In our view, Implied Temperature Alignment captures significantly more information and insight about the expected rate of change at the companies and countries to which capital is being provided than a binary metric of the percentage of companies setting [Science Based Targets Initiative] SBTI-approved targets.

“It allows us to differentiate between the quality of targets and to report in a more granular and insightful way on progress over time.”

As one of the largest asset managers in Europe with assets under management of £1.3trn, LGIM is now using its influence to have a bigger impact in the broader industry.

“The achievement of the overall objective of net zero by 2050 is something we aim to influence as much as we can through actions in portfolios and our engagement with companies, governments and across the wider financial sector,” Lonergan says.

“More companies are setting net-zero goals and aligning their real-world activities and investment plans to support energy transition.”